Guest Post: TBTF Banks Laughing All The Way Home Thanks To HARP

HARP, The Home Affordable Refinance Program, is a streamline refinance program developed to help borrowers who have continued to make their mortgage payments, but have be unable to refinance due to a decline in their home value. Underwater borrowers have been stuck in a “no-win” situation of sorts, being stuck in a well above market mortgage rate (over 6% in many cases) despite being current on their existing loan and maintaining strong credit. Various fees and a LTV ceiling cause the original HARP program to flame out unsuccessfully. Blame was quick to be cast among the major lenders, the GSE’s, as well as the Government.

The early results of HARP 2.0 are in, and the program’s modifications appear to be spurring strong activity. Are the big bad “too big to fail” banks finally relenting and playing ball? As an investor in the securitized mortgage market, I see aspects of the market that the average borrower or market participant does not. In this post I will walk through the economics of mortgage origination for HARP loans, break down exactly how much these banks are making, and how they are able to do so.

Mechanics of Securitization

Many realize that mortgages are sold into Fannie/Freddie pools but few know the intricacies. If a borrower has a rate of 4% on a 30yr mortgage, the investor of the pool only receives 3.5%. The remaining 0.5% (50bps) is split between the servicing fee and GSE “guarantee fee”. Similar 4% loans will then be aggregated together into a pool. A “30year 3.5” is a pool of 30yr 4% mortgages with a coupon of 3.5%. As of today’s close, a 30yr 3.5% pool trades at a price of ~$105.75. If you tack on the 1% origination fee that most charge, and the servicing rights which are valued at another 1%, the originators (Wells Fargo, JP Morgan, Bank of America) are making almost 8points on a standard plain vanilla conforming mortgage.

Historical spreads of what’s known as the “primary-secondary” spread show that mortgage rates are actually higher than they are supposed to be. The current coupon mortgage rate measures the yield of the hypothetical par mortgage (30yr 3’s trade at almost 104 so there’s no tradable par bond). Today that rate is 2.34%. The average 30yr mortgage rate to borrowers, as measured by Bankrate, is currently 3.61%, or almost 130bps over the current coupon rate. Longer term this primary/secondary spread averages closer to 70bps, not 130bps, so rates are about 50-60bps higher than they should be here.

The Value of HARP Loans

HARP loans are particularly valuable in the eyes of investors due to prepayment friction. A borrower may only “HARP” a loan once. As these borrowers are generally all under water on their loan, it isn’t feasible to finance into a standard loan. As such, these borrower are trapped in these loans. The street, with good reason, projects these mortgages to prepay very slowly going forward. To mortgage investors, the stability of these cash flows due to extremely low prepayments is worth significantly more than the average pool.

Our example above showed that a 4% mortgage rate would trade into a 3.5% pool which is a $5.75 profit to the bank excluding origination. The value of HARP loans can vary, but these typically trade up at least 2-3 points over TBA collateral. ”TBA” is the industry jargon for generic new collateral. So if a 4% HARP loan was originated and quoted at +3, the price would be $105.75 + $3.00, or $108.75. Add on the origination and servicing fees and near 11 point profits are being earned.

Lack of Competition is the Driver

One of the quirks with the HARP program is that you’re only allowed to enter into a HARP loan with your original servicer. Noted mortgage analyst Laurie Goodman of Amherst Securities explains, “HARP 2.0, announced in November 2011, introduced significant new benefits to servicers for refinancing their own loans. In contrast, different servicer refinances received at best marginal improvements…This tends to lock a borrower into refinancing with their existing lender, which conveys tremendous pricing power to the banks. A lack of competition has allowed current servicers to charge higher rates to these borrowers, when the economics of origination would suggest lower rates are in order. And borrowers have little choice but to pay the higher rates, as the rules favor same servicer refis to a very strong extent.”

The Menendez/Boxer bill being tossed around Congress proposes to allow borrowers to enter into a HARP loan with different mortgage originators. This would ostensibly create greater competition and lower profits for the three main originators (Wells Fargo, Chase, and B of A). To nobody’s surprise, the big banks are adamantly against this proposal and it’s easy to see why. Not only would their oligopoly on HARP loans be put into jeopardy, but the extra premiums which are able to be extracted would also go down.

Summary

While it is encouraging that more and more underwater homeowners are gaining the benefits of today’s low interest rates, tremendous profits are being made at their expense. Lack of competition is the primary catalyst, but the underlying economics of the large “too big to fail” banks will do nothing but stoke additional anger in the general public. Expect this trend to continue until the dynamics of the program is changed once again, possibly in HARP 3.0. Until then, the cash cow will continue for the TBTF banks.

Since business is all about risk. The more risk you take the greater the reward supposedly is. I guess banking representatives should be the lowest paid employees in the job market. Since they can't fail because they get bailed out of their mistakes by the taxpayers, we need to pay them accordingly. Lets start paying jobs for their value to society and the amount of risk that is taken.

LLoyd!! Here is your yearly paycheck. $10.00. Don't spend it all in one place.

Good read. He forgot to mention about the lack of mark to market value of the underwater/defaulted loan and the how and when the losses are marked on the banks books. Can you say INSOLVENT...... if this happened the FDIC will have a lot of business. It's going to be a slow and painful bleed out.

"CHICAGO (Reuters) - Russell Wasendorf Sr., chief executive of failed brokerage Peregrine Financial Group, had $6.9 million in life insurance and a debt on his private jet when he attempted suicide last month.

A receiver for Wasendorf, who in July confessed to stealing more than $100 million from the futures broker's customers over nearly 20 years, detailed the value of the plane and insurance policies in a court filing on Monday and said he was preparing to unload them as assets.

Peregrine, commonly known as PFGBest, filed for bankruptcy protection on July 10."

Profit should be about risk and rewards, the greater the risk the greater the reward.

When I look at an investment I always ask myself is the "risk" appropriately priced.

These loans are underwater, there is a risk both in repayment and in the asset continuing to lose value. The economy is on a downward slide the bottom not in sight, if it was my money being lent I would want more than 11 points to buy down my risk.

That being said, the bankers have not been appropriately punished for originating those loans in the first place and until that happens the above argument holds no water.

You have to clean house first, and at least an "appearance" of justice has to be established.

"The Federal Reserve chairman said Monday that gauging happiness can be as important for measuring economic progress as determining whether inflation is low or unemployment high. Economics isn't just about money and material benefits, Bernanke said. It is also about understanding and promoting "the enhancement of well-being."

Not mentioned in any of this HARP bullshit is that those of us who were responsible and made our payments continued to get shafted.

My house was purchased in 1998 for $75k. It's modest, about 1500 sf, 4 br 2 bath, 2 car garage and one acre. At the peak of the ponzie the valuation of property around the neighborhood was $350k...mine probably around $325k. I didn't get a second, I didn't draw equity, I didn't do anything except pay my 30 year fixed, 7.5% payment (with escrow) of around 750/month. Usually I paid $800 to $1000 a month with the excess applied to principle.

In spite of being on the 'DO NOT FUCKING CALL' registry, I got a couple of HARP marketing calls and I finally got curious.

I got a call and I told them I was interested in getting my interest lowered from 7.5%. The interest rate had the guy excited. He started talking about getting a new package designed to drop my rate down to 3.5%. To me that would be great. I could make the same payments and pay this bitch off sooner.

He asked me how far behind I was. I told him I was paid into November. He asked, to clarify, if I was almost a year behind on my payment. I told him I was prepaid into November 2012.

He stuttered a bit then asked me what my balance was. I told him it was around $40k, maybe less.

I was told that I didn't qualify because

I was not behind in my mortgage,

I was not 'underwater', and

My balance was less than $100k and it was not worth the refinancing cost to work.

So I am blessed with the privilege of continuing to pay my 7.5% interest rate while those that idiotically bought their little castles and McMansions or drained their equity to buy vacations, toys, and boobs will be allowed to drop their rates and have payments adjusted to what I've been paying all along.

Our government has created a system were irresponsibility has become profitable. There is no penalty for personal financial idiocy; rather, we have a system designed to encourage spendthrifts.

And I am forced to support that system with my mortgage interest and tax dollars.

Pay off the mortgage with a home equity loan. They're a lot easier to get. Go to your local credit union with whom you've had an account for a few years of history - you ARE banking with one, right ? you left a tbtf bank 4 years ago, right ? - and get that home equity loan at 3.5% or thereabouts, for exactly the payoff to the mortgage, no more.